Under the terms of the federal government’s guarantee of CSLP loans issued before August 1995, banks could make a claim for reimbursement if its efforts to collect on the loan were unsuccessful. There were, however, rules defining the “due diligence” required of the lenders before a default claim would be approved. Due diligence required that banks try to find delinquent borrowers before filing a default claim. However, the bank needed only to send registered letters to the borrower’s last known address. If there was no response to these letters, the bank could ask the government to make good on its guarantee, sending the borrower into default.
The certainty of the government guarantee, combined with the relatively small size of student loans and the below-market interest rates they carried, would seem to have diminished the banks’ enthusiasm for pursuing delinquent borrowers. The auditor general was quite damning in this regard: “Our audit found that, in the majority of cases, banks have made little effort to encourage repayment by students.”
Some evidence of the importance of the due diligence rule comes from the 1997 evaluation of the CSLP.49 Since the name of the lender was known, it could be determined if default rates varied across lenders, holding constant the characteristics of the borrowers. It was found that “despite the similarity in [the] borrower profiles, borrowers who used one particular lender … had higher probabilities of default.”Thus, it is possible that lenders varied in their inclination to file claims for loss.